Term structure of interest rates for Malaysian fixed income security
This study investigates the term structure of interest rates for the Malaysian fixed income security. This study is relevant because Malaysia has one of the fastest growing bond markets in the region. The general objective of this research is to study the behavior of the term structure of inte...
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| Main Author: | |
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| Format: | Thesis |
| Language: | English |
| Published: |
2012
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| Online Access: | http://psasir.upm.edu.my/id/eprint/67271/1/FEP%202012%2016%20IR.pdf http://psasir.upm.edu.my/id/eprint/67271/ |
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| Summary: | This study investigates the term structure of interest rates for the Malaysian fixed
income security. This study is relevant because Malaysia has one of the fastest
growing bond markets in the region. The general objective of this research is to
study the behavior of the term structure of interest rates of Malaysian fixed income
security by focusing on the issues related to the predictive power of forward to the
future spot rates, long rates to short rates, and forward rates to inflation. Another
important objective is to explore the efficiency of Malaysian fixed income security
market in terms of prices and yields and to find out to what extent they are driven
by the market forces. The final objective here is to interpret the behavior of the
yield curve of the term structure of interest rates of Malaysian fixed income security
market and to find out which theories can explain the behavior of this market,
in addition to testing the liquidity premium theory. This research differs from
earlier studies in several ways. First, due to the existence of limited number of
studies that focus on Malaysian bond market, this investigation addresses several issues in corporate bond market. In addition, this study examines the behavior of
the term structure of interest rates in the government bond market. Second, this
work compares and scrutinizes the behavior of the yields in both government and
corporate bond markets. Third, an analysis on Malaysian corporate bond market
seems to be less common in this context. A number of important research questions
can be raised in this regard. Are the forward rates useful in the prediction
of future spot rates and inflation? Does the market reflect the true value of the
security by allocating fair yields and prices to investors? Which theory of the term
structure can explain the behavior of Malaysia fixed income security market? The
research has responded aforementioned questions by employing CIR as one-factor
model as well as the extended BDT two factor model with the use of Financial
Mathematical Computational tools in MATLAB. Here, it is worth mentioning that
special code has been developed to calculate the zero curves and forward rates.
The market participants in MGS and MCB based their investment decision on
their own preferences according to their assets and liabilities. The interpretation
of the TSOIR and yield curve shapes is influenced by the dominance of the institutional
investors in the market as giant players. Interestingly, without a doubt the
extended BDT two-factor model confirms the results obtained by CIR one-factor
model especially in predicting the shapes of the compartmentalized market yields
in both MGS and MCB which are humped curves with few exceptions.
The yield-analysis by BDT indicates that the market mis-allocated the yield as
the model fair yields for the entire issues of MGS are higher than the market current
yields resulting in investors not getting what they deserve to get from their
investments. In addition, the yield-analysis results by BDT for MCB are found to
be similar to the result obtained from MGS except for B1 as the current market yield is higher than the model fair yield. Here, it also deserves emphasis that priceanalysis
of MGS reveals that model fair prices are higher than the current market
prices. However, MCB exhibited different behavior for its different classes as the
model fair prices are found to be higher as well as lower than the market prices for
a set of bond classes. Interestingly, the yield-analysis reveals that both CIR and
BDT models produce similar results. Here, it should be emphasized that although
CIR model is conventionally a one-factor model, it can successfully capture the
dynamics of interest rates.
The mean YTM analysis by CIR for MGS and the eight different classes of
Malaysian corporate bond when comparing the different maturities within the
same class of bond fail to support LPT proposition. While the mean-analysis result
by BDT shows clear evidence of the liquidity premium when investors holding
the MGS to the maturity date. The mean YTM reveals normal upward curve with
the increase of the maturity spectrum. This probably compensates the risk-averse
investors to offset the risk of uncertainty in long term investment. However, the
mean-analysis results by BDT for the MCB shows mixed evidence.
The spread-analysis which compares the same maturities within MGS and different
classes of the corporate bond by CIR model shows mixed results. The analysis
confirms some evidence of the LPT as the investors in some classes of the corporate
bond in certain maturities will be getting positive access return in addition
to the risk-free rates. In a similar vein the spread-analysis by BDT reveals that
each maturity spectrum has different segmented behavior with inbuilt liquidity
premium. The higher classes of MCB exhibited positive spread while medium and
lower classes shows mixed spread results. The findings of the spread-analysis deserve
a special emphasis in the sense that the MCB investors may formulate their investment strategy for their portfolio by using MGS as a benchmark. Turning to
the predictive power of the variables of interest following findings deserve emphasis.
The long rates obtained via CIR model could be incorporated in the model to
predict the short rates. While Granger non-causality test between short and long
rates for MGS suggest a unidirectional causality that runs from long rates to short
rates. In addition, for the predictive power of the forward rates to future spot
rates by BDT model, the pooled OLS does not seem to capture the dynamics of
the variables of interest. However, there is strong bi-directional causality between
the variables of interest. For the predictive power of the forward rates to the future
inflation, the regression leads to misleading results for the standard errors.
OLS does not capture the linear relation between the forward rates and inflation.
Meanwhile the Granger non-causality tests between forward and inflation rates for
MGS do not provide any causal relation between the forward and inflation rates.
The bounds test results support the cointegration among the variables of short and
long rates under CIR model at 10% significance level. The result for the variables
of the forward and spot rates by BDT model reveals that the computed statistics
are supportive for an existence of cointegration at 5% significance level. Finally the
bounds test result for the variables of inflation and forward rates suggest that there
is a strong cointegration. The cointegration analysis reveals significant empirical
support for the validity of the expectation hypothesis in Malaysian fixed income
security. Finally, the overall research outcome would be of great importance to
investors and other market participants in formulating their own strategies based
on the information which can reflect the true value of the securities. |
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